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Healthy Boost For United Natural Foods

Posted: Sep 05, 2008 13:46 PM by Stephen Simpson

Tickers in this Article: UNFI, WFMI, WMT, KR, BJ, COST

This hasn't been the easiest year for United Natural Foods (Nasdaq:UNFI). The once richly-valued distributor of natural and organic foods has stumbled on both operational challenges and worries about its largest customer Whole Foods Market (Nasdaq:WFMI). But as is sometimes the case when one-time high-flyers stumble, perhaps now is the time for investors to do a little extra due diligence on a leading company in a growing market.

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Buy the Numbers
The fiscal fourth quarter results (and guidance) that United Natural Foods reported on Wednesday were good enough to send the stock up a bit, but not terribly impressive on their own. Reported sales grew 29%, while sales adjusted for acquisitions and an extra week in the quarter grew about 12%. Gross margins edged up slightly, but operating income was soft even with the inclusion of the extra week. For the full year, cash flow was down whether you look at the standard free cash flow figure or the structural free cash flow number.

It didn't help matters any that United Natural's sales were strongest in its smaller units. Food service and supermarkets showed solid growth, but together account for less than one-quarter of sales. Conversely, growth at independent stores and so-called "supernaturals" (the company's term for businesses like Whole Foods) was less impressive, although still positive.

As is so often the case, the past is all well and good, but it's the future that we need to concern ourselves with when considering investment candidates. While I have long liked United Natural as a company, I've always shied away from the stock thinking that it was too expensive. That may no longer be the case.

Past The Passing Fancy Stage
I believe that we are well past the point where interest in natural and organic foods could be dismissed as a fad. That strikes me as a good thing for this company. It is true that Wal-Mart (NYSE:WMT) is getting more involved in the market, but it's also true that United Natural foods customers like Kroger (NYSE:KR), BJ's Wholesale Club (NYSE:BJ) and Costco (Nasdaq:COST) are as well. As United Natural is the largest independent distributor of natural and organic foods, I find it hard to imagine that it won't benefit from the ongoing overall growth in the market.

That is not to say that there are not some concerns at present. The company's ROIC is lower than I would like to see, and food distribution is a low-margin business. Plus, there are legitimate concerns about whether economic realities will force consumers to trade down in the market and away from the often higher-priced natural and organic foods. (To use return on invested capital to find value, read Spot Quality With ROIC .)

Bottom Line
But I'm going to argue that these are largely transitory issues. True, this will always be a low-margin business, but I do think it's possible for the company to boost ROIC back to a double-digit level and I do believe that when the economy eventually recovers, shoppers will come back to the products they want to buy.

For more on analyzing companies in this sector, be sure to read our related article Analyzing Retail Stocks.

By Stephen Simpson

Stephen Simpson, CFA, has worked as an equity analyst for both sell-side and buy-side investment companies, and presently works as a sell-side equity research analyst. He has worked as a consultant for the healthcare sector, and has written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson is the editor of Kratisto Investing, a website devoted to financial analysis and personal commentary.

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